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Had a thought about ABCT

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Smiling Dave posted on Tue, May 31 2011 9:04 AM

1. Look at what's happening in Europe. The basic problem the PIIGS are having is that they borrowed money they could not possibly pay back.

The same thing seems to be true about the US housing fiasco. The essential problem is that people borrowed money they could not pay back.

Whic leads me to the question, is this always a feature of a business cycle? Are the low interest rates Mises points to as the culprit just a way of ensuring this happens, by having tons of money printed [to create the low interest rates] which is then lent to people who cannot pay back? After all, the higher the interest rate, ceteris parebis, the higher the quality of the person borrowing the money in term of ability to repay. The lower the rate, the more deadbeat types can get money. This is both because the bank and the customer think they can meet these low rates [which is what Mises emphasized], and because all that new money force the banks to look for new customers they would have rejected otherwise.

2. Taking a larger view, would Mises have agreed to all of the above? Was he writing about normal times, where banks lend only to businesses, [or to consumers only for home loans under very strict rules]? Would he be the first to say that in mad times like the 2000's, with liar loans and all the other insane govt meddlings, the explanation of a business cycle need not look for subtleties like entrepeneurs fooled into malinvestments by the low rates, investments in the higher levels of production when the demand isn't really there, etc etc, because we have all the ingredients for a boom and bust for much simpler reasons?

3. Now don't get me wrong. When I say deadbeats, in order to include Mises' classical ABCT as a special case, I do not mean only people of low character who never intended to repay. I mean people who are borrowing and, knowingly or not, good intentions or not, whether it's their fault or not, and whether they know it or not, cannot possibly repay.

4. This point of view has an appealing simplicity to me. People borrow money, lots and lots of it. They spend like drunken sailors. This is the boom. One day they have to pay the money back, but they can't. This is the bust.

They never were able to repay in the first place, because they are the economic equivalent of drunken sailors. The money they borrowed was never going to be repaid, for various reasons that depend on the particular boom and bust being studied.

It makes so much sense, is so appealing.

Borrow a lot of money = boom.

Don't pay it back = bust.


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It's easy to refute an argument if you first misrepresent it. William Keizer

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Sounds pretty good.  I mean, it's never perfect when you distill things down that far, but I'd say that's a pretty decent way to introduce the concept to someone in 5 seconds.


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A few notes:

- All government spending, subsidy, taxing, borrowing and regulating distorts the economy because the government is not subject to the discipline of profit & loss. Unlike market producers, the government's actions do not have anything to do with what people want and need (besides itself).

- Inflation is just another way the government gets revenues. However, unlike other forms of revenue and subsidy which have a localized impact on the particular good or service, inflation affects all goods and services to one extent or another. Most importantly, it affects the "time-structure of production". Specifically, it causes the time structure of production to attempt to both widen and lengthen simultaneously as capital investment and consumer demand are simultaneously increased.

One of the key blunders of mainstream macroeconomic theory is the failure to distinguish between consumer goods and producer (higher-order) goods. The result is that mainstream economic theory fails to comprehend that investment and consumption represent alternative and competing uses of wealth.

I think it is a mistake to focus in on the credit aspect of inflation since you don't even need to have credit in order to have inflation. Governments used to simply debase coins which is equivalent to printing money and some governments (US (continentals), Weimar, Zimbabwe) have outright printed paper money. While money-printing does have a systemic effect on the interest rate and this does lead to bad loans, non-payment of bad loans is only a symptom of a much larger problem, that the productive capacity of the entire real-goods economy has been restructured to meet illusory demands which took away resources needed to meet more pressing demands. This is what causes the crash. People are starving in the streets because the farms were shuttered during the boom, tractors auctioned off to be melted down and turned into iPods or whatever it was that people were buying with the hot, inflationary cash. They're not starving in the streets simply because bad loans were made. If that's all that were the matter, the Keynesians would be right, all that would be needed is for the government to "inject cash" to restart demand, causing farmers to un-shutter their farms and fire up the old tractors which had been sitting idle. But capital resources do not sit idle waiting in case the government starts injecting money into the economy, they move to their most valued use. So permanent changes occur to the capital structure of the economy which, when the crash sets in, are revealed to have been a terrible misallocation of capital to low-value uses. The housing boom is the perfect illustration. The tech bubble right before it is also instructive.

Clayton -
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Clayton makes a good point.  I probably should have added the caveat that I wouldn't go so far as to say:

"the explanation of a business cycle need not look for subtleties like entrepeneurs fooled into malinvestments by the low rates, investments in the higher levels of production when the demand isn't really there, etc etc, because we have all the ingredients for a boom and bust for much simpler reasons?" that is an important part of the whole cycle.  But as far as explaining what's bad, why it's bad, and how it isn't a fault of "the free market" in less than 5 seconds, I'd still say Dave makes a good observation.


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